Traditionally donors have relied on overhead-cost ratios, the amount an organization spends on administrative costs compared to program costs, as a means to evaluate organizations. And a number of nonprofit reporting organizations, including Charity Navigator, still use over-head cost ratios as a primary component of their assessment of nonprofits (although Charity Navigator is working to expand its assessment criteria). In my previous blogs for Greenlights, I have written about the importance of focusing on and tracking outcomes, the changes to clients or the community that come about as a result of a program or service. But, should we be as concerned about overhead costs as we are about outcomes?
A number of leading nonprofit thinkers, including Dan Pallota and Paul Brest, have argued compellingly that a focus on mission success should drive organizational decisions, not overhead-cost ratios. They note that in order for nonprofits to truly make an impact and create sustainable change, nonprofits must be willing to invest in technology, evaluation, and human capital. These capacity building efforts are necessary in order to create more efficiency and effectiveness within the sector. Brest writes, “Achieving a low overhead ratio drives many nonprofits to behaviors that make them less effective and means more, not less wasted dollars.”
Nell Edgington of Social Velocity believes the distinction between program and administrative costs is meaningless because it is simply not possible to separate program dollars from overhead and capacity building efforts:
“If a nonprofit organization is creating change, then everything they do is in support of that change. How can a program run if there is no financial engine (fundraising) to fund it? If there is no building or space to house it? If there is no financial management or regular audits? If there is no regular evaluation of whether the program is making a difference?”
GuideStar, a leading nonprofit information organization, also believes that using financial figures to judge nonprofits can be very misleading. While they note that nonprofits have an important obligation to responsibly manage their finances, there are many different factors that can affect overhead including the size, age and location of the nonprofit organization and the fact that some types of nonprofits generally have higher ratios (for example, museums must pay for security). They also feel that a nonprofit’s organizational lifecycle can affect this figure, with newer organizations often facing higher infrastructure costs. Guidestar goes on to emphasize that the ultimate test is how well the organization performs its mission.
Finally, according to BoardSource, there are no generally accepted standards for how much (or little) should be spent on overhead and no universal formula for calculating overhead.
So, why are financial measures like overhead ratios regularly used, and why do many nonprofits feel pressure to keep their overhead as low as possible? How can we work to educate donors, funders, and the community to have a more realistic understanding of what it takes to deliver on outcomes? For more information on this topic, look for my next blog in March.